Three things you could do today to boost your superannuation

Superannuation is confusing so people often just neglect it for very long periods of their working life. So, I've put together a list of 3 simple things you could do easily today or over the next couple of days that will help make a big difference over the long term.

1. Check your investment option

Almost everyone, particularly those earlier in working life, has the default investment option. Usually called the Balanced fund. The Balanced fund or default investment option in most super funds has about 60-80% invested in growth assets and 20-40% invested in defensive assets. Anyone under 50 years of age has at least 10 years before they can access their superannuation so they can afford to take on the extra risk and volatility of a growth orientated portfolio. Check your super funds performance figures for the default fund and the high growth fund. The Precision Wealth Management 10 year return for the 70% growth portfolio compared with the 100% growth portfolio is 6.94% and 8.00% respectively (keep in mind the GFC was right in the middle there). If we take a typical situation, someone with $100,000 in superannuation and net contributions of $7,000 pa (increasing at 3%), the difference after 25 years would be $1,114,000 compared to $1,350,000.  Not a bad difference for choosing one option over the other.

Note: A higher growth investment option is more volatile and can at times provide lower returns than the other options. You need to accept this and ensure you are invested over the long term.  

2. Check your insurances

Superannuation funds, particularly employer sponsored funds have default insurance inside them. This is good as most people don't go to the trouble of making sure they have adequate cover.  Even though most young families don't have adequate cover, there are some people where the default insurance cover is more than they need.  Some single people without any dependents can have death cover which isn't needed, or maybe they have income protection inside superannuation which doubles up on a policy they already have outside superannuation.  If you can save $300 per year (increasing at 3%) in unnecessary insurance premiums, then you could add an additional $30,000 over 25 years.

Note: Most people, particularly those with young families don't have enough personal insurance cover. Carefully consider your needs before making changes to your insurances and seek advice if you are unsure.

3. Make additional contributions

To have the sort of lifestyle most of us desire in retirement, the standard employer contributions aren't enough and freeing up some cash flow to direct towards superannuation can make a big difference. The good thing about making contributions to superannuation is that they can come from pre tax income if salary sacrificed.  So if you can free up $50 per week from your budget, that is actually $75 of pre tax earnings (for someone on the 34% MTR, and even more for those on higher tax rates). If we take an example of $50 savings per week, grossed up to pre tax earnings and salary sacrifice that over 25 years (increasing at 3% pa earning 8% pa) that is worth an additional $318,000. For most full time workers, the best way to contribute to superannuation is via salary sacrifice however make sure you stay within your contribution caps. If you are a low income earner, making non concessional contributions (after tax contribution) to receive the government co contribution is a great little boost as well.

There are obviously other things that can been done to boost retirement savings, however if it gets too complicated, people won't do any of it. So this list of 3 is a great place to start and you don't need to do all of them. Even just 1 or 2 will help make a big difference over the long term.

Changes to superannuation - what it means to you

The government has announced last week that it will delay the phase in of the increase of the compulsory superannuation contributions to 12% and repeal the Low Income Super Contribution. They have also previously proposed an increase to the Age Pension Age. But before we go getting too upset at the current government, the previous Rudd/Gillard government reduced the concessional contribution caps, halved the superannuation government co contribution and also increased the Age Pension Age.

So what does all this mean?

It basically means that if you want a financially comfortable retirement, you need to take some responsibility yourself to plan and accumulate funds. I can think back just 5 or 6 years where we had concessional contribution caps of $100,000 and salary sacrificed contributions didn't count towards other government income assessment such as Centrelink entitlements and government co contributions.  Providing the person was earning a reasonable income, they would be able to accumulate a decent portfolio in only a few years. Now, with concessional contribution caps $35,000 or $30,000 and all the other reduction in benefits as well, people need to plan many many years in advance to give themselves a comfortable retirement.

Lets take a 25 year old. Earning $60,000 per annum and say their income will rise at 4% per year. They currently have no superannuation and we'll say they'll retire at age 60. We'll also assume that the employer contribution rate is 9.5% and stays at that throughout. If the average superannuation earning rate is 7% (net of fees and tax) per annum, they will end up with $1,223,558.

Seems like a lot! But if we discount for inflation at 3% it is the equivalent amount of $434,832 in today's dollars. With modern day life expectancy, this is really not enough for a comfortable retirement considering the governments moves to reduce the welfare available to Age Pensioners.

If that same person was to be able to save just $50 per week from the start from their cash flow and salary sacrifice the grossed up amount to superannuation, they'd end up with just over $2,000,000 in super which is about $712,050 discounted back to today's dollars. That is significantly more and would provide a much more comfortable retirement income stream. It's $50 per week. Most people spend much more than that on non essentials.

Do people do that? No. Why? well, I guess they want to spend the $50 per week now and hope for money later on. Or maybe complain when they reach retirement that the government doesn't do enough. Or maybe they'll try to create wealth very quickly near retirement through very high leverage and lose even more (ie. Storm Financial). As a financial adviser, I can't help anyone who doesn't want to help themselves.

We have been through a period where the generosity from governments in terms of concessions to build for retirement savings has been quite high, and now when the budgets tighten, the responsibility falls back to each and everyone to do something about their own future.  It's so easy to ignore wealth creation and perhaps for those around 25 to 30 or even 40, there is a lot going on. House, marriage, children etc, but don't wait until you are 55 or 60 and then think, I should really do something about my retirement because with all the changes happening to super, there will probable be less there than you think.

Cheating Rife in Financial Planning

This blog is spurred on by a recent article in the Brisbane Times - Cheating rife in financial planning

The article talks about the recent scandal in the financial planning industry arising from advice given from Commonwealth Bank financial planners. I have to be careful what I say here because the CBA has a lot more money to spend on expensive lawyers than me, but we'll see how we go. And if any CBA representatives are reading this, "these aren't the droids you are looking for".

The article talks about the lack of education and work experience required to become a financial adviser. Hallelujah!! I've been saying this for years. The government keeps trying to improve the industry with constant reforms around disclosure etc, but they continually fail to miss the point. Increasing education requirements plus including some workplace work experience/traineeship requirement etc will without a doubt improve the industry, why? Because it will increase the knowledge of the financial advisers resulting in better advice, obviously, but more importantly it'll weed out the dodgy/fly by nighters who won't choose financial planning as a get rich quick industry as they don't want to invest the years to become one. They'll move into something else, snake oil salesman or something else where they can sell and make a quick dollar.

Doctors are always up on lists of most trustworthy professions because they need to commit so much time into education then on the job training, that they all passionately want to be one and then once they are a doctor, they do everything they can to be the best they can be.

Then onto the next point and that is financial planning within the banks. Firstly, the banks are a great place for budding financial advisers who have very little financial planning education and no workplace training to get a job straight in as a financial adviser, because the banks don't care. There is no KPI's in the bank that measure successful client outcomes. Most small financial planning firms won't hire an adviser without experience, they'll often hire those as paraplanners, who write the plans for the financial advisers so they get on the job experience and knowledge before being a financial adviser.. To start straight off as a financial adviser, then banks are a good place to start.  Secondly, when the financial advice is coming from the place that owns the products that are being recommended, there is a massive conflict of interest there. I'm calling dingo on that. Dingo Dingo Dingo.

If we look at the failings in the financial advice industry, they all relate to either a lack of education and/or a conflict of interest. Westpoint/agricultural schemes etc - massive commissions created a conflict of interest. Storm financial - were paid a % of funds invested, so they had a massive conflict to ensure massive amounts were invested and the Commonwealth Bank scandal, well, take your pick, was it lack of knowledge and education or a conflict of interest in the advice coming from a product provider. I'll bet a combination of both.

If we ensure all advisers have a strong educational background, plus a minimum traineeship type program, you'll ensure advisers know how to give good advice. Then if you remove all conflicts of interest, mainly product ownership and ties, then the advisers will be able to solely work in the clients interests.  Adding 5 more pages of disclosure to an already large document that clients already don't read doesn't help anything.

If you would like to watch the Four Corners report into the CBA financial planning scandal, it can be view here. It was very frustrating for me to watch.

Mortgage Comparison Rates

With mortgage interest rates in the spotlight this week with many of the banks reducing their longer term fixed rates, I thought I would take a look at mortgage comparison rates.

Mortgage comparison rates are one of those government legislation's that try to help, but miss the mark and actually do the opposite. Mortgage comparison rates are meant to take into account other fees and charges, not just the mortgage interest rate, to give you an overall interest rate however there are a couple of problems with this.

Firstly, by taking flat dollar fees and converting them to an interest rate, an assumption needs to be made on the loan size and length of time the loan is repaid. This is standardised as a $150,000 loan paid off over 25 years. Based on all the possible loan sizes and actual repayment lengths, this might suit 1 mortgage holder in Australia out of millions.

Lets have a look at some of the problems. Some loans might charge a 5.1% interest rate with no annual fee, or if you pay a $200 annual fee, you get the discounted rate of 5.0%. So if your loan is above $200,000, it's a no brainer, you pay the annual fee to get the discount. BUT, the annual fee loan will then show a worse comparison rate, because they are all calculated with a loan balance of $150,000.  In real life you wouldn't stick with the 1 loan for 25 years. You'd pay the annual fee for the discounted rate until the loan balance was below $200,000, then you would revert to the no annual fee option.

The other big problem with comparison rates is when it comes fixed rate loans. For fixed rate loans, the comparison rate is still on the same mortgage size and with a term of 25 years, but fixed rate loans are generally only fixed for up to 5 years. In these instances, the comparison rate is calculated by reverting the loan back to the standard variable rate for that lending institution for the remaining term of the loan.  This is just going to give you all sorts of inaccurate figures on the comparison loan. The bank may be offering a great fixed rate but has a terrible variable rate, so the comparison rate on the fixed loan will show a bad outcome, even though it may be a good option for you, just for the fixed period.

It isn't hard to calculate how much a loan is going to cost you. Multiply the interest rate by your loan balance then add on any flat fees the bank charges annually. This will show you the annual cost in dollar terms for you. Then, if there is an upfront fee, you need to apply some qualitative analysis here as well as quantitative, is it worth it?  If an upfront fee is $500 but the loan is saving you $3,000 a year, it won't take long to get your money back. But if the upfront fee is $500 but the loan is saving you $100 per year, you might think, too many things could change in 5 years for this to even pay me back.

I think with the competition and the constant changes in the mortgage market as well as changes to your own personal circumstances, you'd be crazy to stay with the same loan for 25 years, so the comparison rate shows you very little, you just need to take it upon yourself to look at the other costs outside of the interest rate.  At Precision Wealth Management we can help clients get mortgages with the interest rate rebated, so the interest rates out clients pay are less than any advertised interest rate or comparison rate.  Call us on 1300 200 012 to see how we can help you.

Budget Breakdown

Well last night we received the first Abbott government budget and it was one of the most highly anticipated budgets in recent history.  The hype was almost like awaiting the release of a high budget blockbuster movie, except a lot more boring.

There was so much talk in the media about this GP co payment of $7 and "the pensioners getting hit hard" but the fact of the matter is these are media hype lines and the major changes are not this at all.  How often does a family go to the GP? 10 or 20 times a year? That's $70 or $140 per annum. Not a big deal compared to some of the other changes.  I personally haven't been to the GP for at least 2 or 3 years. It's funny that the medicare levy increase to 2% was introduced and legislated by the previous government and no one battered an eyelid. For a family earning $80,000, that is an additional $400 in medicare levy, a lot more than the GP co payment. So, lets have a 'media hype free' look at the actual budget changes that matter.

• The 'Temporary Budget Repair Levy' - This is basically a temporary increase to the top marginal tax rate.  Someone earning $200,000 will pay an additional $400 per annum in tax and someone earning $300,000 will pay an additional $2,400 in tax.  It is important to note the Fringe Benefit Tax rate is also increasing to reflect the increase in the highest marginal tax rate due to the TBRL and the increase in the medicare levy.
• Abolishing of Dependent Spouse Tax Offset and Mature Age Worker Tax Offset - These are tax offsets available to older Australians who are still working.  This could be additional tax of up to $2,971 for some older Australians. 
• Removal of the First Home Saver Account scheme - This means those saving for a house now won't be eligible for $1,020 government contribution each year. For those in the scheme, they can withdrawal their balance without restriction from 1 July 2015 so there is no penalty for those who commenced the account.
• Age Pension - The Age Pension Age is being increased to 70 by 2035. This was always inevitable and don't expect there to be no more increases. When the age pension age was first introduced, our life expectancy was younger than the Age Pension Age at the time. So you were lucky to live long enough to claim it. There has been a massive shift in the sense of entitlement. We feel we deserve decades of claiming Age Pension which is hurting the governments budget.  Don't cry poor and say my body won't allow me to work that long. The change is 20 years away and it's increased by 3 years. Plan, save, invest and fund your own retirement if you want to retire earlier. Also, it is proposed that the Age Pension rate will be increased in line with CPI rather than the higher rate of a number of other indexation rates. This may result in the Age Pension rate increasing slower than it otherwise would from 2017.
• Abolishing the Seniors Supplement - This is a payment for those who aren't eligible for age pension but hold a Commonwealth Seniors Health Card.  This removal means couples who are eligible will now not receive the $1,320.80 per annum ($876.20 for a single).
• Deeming rates - For most income assessment for government benefits, they apply deeming rates for financial investments, rather than assess the income those investments actually earn. The thresholds for deeming rates will be decreasing which means the deemed income will increase, reducing any benefit for those on the income test where the deeming rates apply.  This together with the previously legislated change to the income assessment of superannuation pensions from 1 January 2015 will likely make a big difference.  It will be very important for people who will be in this position to commence pensions before 1 January 2015 as existing pensions are grandfathered.
• Family Tax Benefit Changes - There is multiple changes here and I won't go through them all but as I can see they are all reductions, removal of indexation, no increase threshold for additional children, reduction of supplement, reduction of income thresholds. For some families with circumstances that spread across many of these changes, this could result in a reduction of Family Tax Benefit of many thousand's of $.

So as you can see, there is plenty of cuts to welfare and tax offsets and also increased taxes. Some of these are significant depending on your circumstances. So if you want to complain about the budget, there is plenty there to complain about. Just don't complain about the minor media hyped changes such as a GP co payment when in reality it is a small cost compared to the other changes.

This isn't all the changes either, there was also changes in other areas such as Disability Support Pension, Newstart Allowance, HECS, Medicare Levy Surcharge and Private Health Insurance Rebates etc.

If you have any questions on how this may impact you specifically or would like details on some of the other changes I haven't talked about, please call me on 1300 200 012 or email on glenn@precisionwm.com.au

Anti Detri What?

When talking about Anti Detriment Payments (ADP), the response is often, Anti Detri what? But the reality is ADP are a little known part of superannuation that can be of large value.

An ADP is a additional payment, paid on death, to eligible dependents on receipt of a superannuation lump sum death benefit.  It is meant to be a refund of the contributions tax paid by the member over the life of their superannuation benefit. As it is almost impossible for any member to calculate the actual contribution tax paid over the life of their superannuation, the ATO have provided a formula to calculate it (this formula is provided at the end of this blog).  ADP are funded by providing the fund with a tax deduction equal to the ADP grossed up by the superannuation tax rate of 15% but not all superannuation funds pay ADP though.

You might be thinking, this is all a bit complicated and so what?

This is not a payment which is only applicable to deaths in younger people and it isn't only applicable for deaths in older people.  It's a payment which is available at any age!  So, how much can this benefit be?

Lets have a look at John, a 40 year old with a wife and 2 children, who unfortunately has been diagnosed with a terminal illness.  He has a superannuation balance of $300,000 (100% taxable component) with an eligible service date of 1 July 1993 and an insurance death benefit of $120,000.  Often people would claim the insurance benefit (virtually all death benefits will pay on diagnosis of a terminal illness) and then withdrawal the entire $420,000 under the terminal illness condition of release of superannuation.  They then can use the funds to enjoy their final months together and leave the spouse with the balance so she isn't waiting for the death benefit after death.  If you don't have anyone eligible for an ADP, then this would be a good strategy.

Unfortunately, when you withdrawal your superannuation balance prior to death under terminal illness, you are no longer eligible for ADP.   In this case for John, his ADP could be $52,941, that's right, over $50,000! That is a lot of extra money for the spouse and children.  I've seen people miss out on this sort of money. Even if they wanted some funds from superannuation prior to Johns death, they could have rolled the majority of the balance over to another fund that pays an ADP, then claim the insurance benefit, and withdrawal those funds.  It is important not to mix the insurance proceeds with the superannuation balance if you want to withdrawal some funds prior to death.

ADP can also apply to older people.  As the superannuation system ages, so does the number of retirees dying with a superannuation balance remaining.  Some funds, but not many, also pay ADP from pensions as well as accumulation accounts.

Bob is 74 and has $450,000 in a pension. He has an eligible service date of 1 July 1980.  If Bob has his pension in a fund which offers ADP and Bob's wife Mary receives his superannuation as a lump sum, she could receive an ADP of $64,671.

So, to conclude, I would just like to run through a few main points when it comes to ADP:

• Not all superannuation funds offer it and even less pensions offer it. Ensure yours does.
• To receive an ADP, the beneficiary must be a spouse, former spouse or child.  They must receive the benefit as a superannuation lump sum death benefit. Withdrawing funds prior to death or nominating a reversionary pensioner on a pension means they will not get it.
• If the person receiving the ADP is to old to re contribute the funds back to superannuation, you need to determine if the ADP is worth it if there is negative tax and Centrelink implications by having the funds outside the superannuation environment.
• It is very very difficult to get the benefit from a Self Managed Super Fund.  You need to have sufficient funds in reserves of the fund prior to death (which is essentially your own money), then you pay the reserves as an ADP (which again is your own money). Then the SMSF will receive a large tax deduction to carry forward so the funds are then recouped over many years of not paying tax within the fund. For people nearing retirement or in pension phase. This is of no use to them. For those who are paying tax within a SMSF, recouping a $50,000 or $60,000 ADP can take decades. 

If you would like any further information on Anti Detriment Payments or any other financial matter, please contact me on 1300 200 012 or glenn@precisionwm.com.au

The formula for calculating an ADP is in the picture below. Although it looks complicated, for people with an eligible service date (the date you first started working and received superannuation contributions) after 30 June 1983, it will simply be the taxable component of your superannuation fund multiplied by 17.647%.

Direct insurance - what's it all about?

Are you a stay at home parent that watches a little bit of day time TV, or have you had a sick day and watched TV during the day?  If you have, then you have more than likely seen the constant advertisements both in the commercial breaks and the infomercials during the morning TV shows for personal insurance; generally death cover and income protection.

I have to admit, they do a great job at advertising their insurance. With the background music, the acted out examples of someone being off work and needing income protection, happy families etc. and also someone ringing up to take out an insurance policy.  They also like to give you the cost of the cover in small frequencies, generally telling you the cost in a daily or weekly amount, so that it feels like it is less expensive. "$3 a day - less than a cup of coffee" sounds a lot better than "more than $1,000 per year". While $1,000 per year seems like a lot of money, $3 per day is nothing, right?

Don't get me wrong, I do believe many Australian's lack adequate personal insurance and if those advertisements help families take out additional cover, then this is a good thing.  But is it really as attractive as they make out? It doesn't take too long to see that the answer is a resounding no. If you visit the Real Insurance website, you can view their commercials to have a closer look and make a comparison.

In the commercial, it gives an example of a 36 year old female receiving $5,000 of income protection cover. The cost of this is $32.33 per month. Firstly, if you look at the small text in the advertisement, it says it is for cover with a 90 day waiting period, payable for 6 months. This means that in order for an individual to be entitled to receive any form of payment, their illness or injury would need to be serious enough to prevent them from working for 90 days.

Most Australian families with a mortgage do not have sufficient cash reserves to provide for the family for 90 days.  Also, the advertised benefit only lasts up to 6 months.  What happens then? There is a reasonable chance that an illness or injury, that is considered serious enough to keep you out of work for an initial period of 3 months, is likely to also prevent you from working for longer than the additional 6 month period (9 months in total).  According to Financial Advisers Australia, when a person is off work for more than 3 months, the average duration of claim is 4.2 years¹.

The company’s Product Disclosure Statement for their income protection product also states that they will not pay a claim for a sickness or injury which is a direct or indirect result of a mental health disorder or illness.  According to AMP claims statistics from 2011, in 19% of all claims, the leading single cause of a claim, was as a direct or indirect result of mental illness².

I have compared the cost of the policy advertised in the Real Insurance advertisement with a retail policy for the same 36 year old white collar non-smoking female.  You could have a policy which has a 90 day waiting period, however instead of the 6 month benefit period advertised by Real Insurance, the retail policy has a benefit period of 2 years (as a 6 month benefit period is not available on retail policies) and costs $32.26 per month (which is almost identical to the cost of the Real Insurance policy). This retail policy also includes cover for mental health illnesses, subject to underwriting. So for virtually the same cost, you have a longer benefit period as well as a policy that includes mental health, which as previously discussed is the leading cause of claim for income protection.

Other comparisons between direct and retain insurance, include:

• Direct insurance only allows for self-ownership; the policy cannot be owned by superannuation, which is generally the best ownership option for death cover. In addition, the policy cannot be owned by a third party.
• Direct insurance does not allow the option for level premiums. Level premiums allow the individual to take out cover that doesn't increase in cost each year as a result of the individual’s increasing age.  In the long term, this can result in significant savings for the policy holder.
• Although direct insurance allows individuals to choose the benefit period on income protection, their maximum benefit periods are still considered short term (either 2 or 5 years). They do not provide the option for a benefit period to age 65.  This is not always suitable as generally speaking, most young people are going to be reliant on their income for a lot longer than 2 or 5 years.

There are also many other limitations with direct insurance policies and as I've shown above, they really are not the cheaper option.  To review your personal insurance and to discuss policies that will provide the most appropriate coverage for you and your family, please give me a call on 1300 200 012 or email at glenn@precisionwm.com.au.

^{1 http://www.faa.net.au/income_protection.html}

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